Focus on Bank Liabilities, Not Bank Assets

John Cochrane has a great column in today's Wall Street Journal on how to create a better banking system. He says that we should focus on the nature of bank liabilities (demand deposits, in particular) rather than on the riskiness of bank assets.

Back in 1993, in my discussant's comments on an Akerlof-Romer article on the savings and loan crisis, I made a similar argument. Here is an excerpt of what I then wrote:

Traditional banks are peculiar institutions. Traditional banks have depositors who want short-term, liquid, riskless assets. Yet these deposits are backed by long-term, illiquid, risky loans. This incongruity is fundamental. As we have seen, it cannot be easily fixed by a government policy such as deposit insurance.There is, however, a simple, market-based solution: mutual funds. Individuals who want truly riskless assets can invest in mutual funds that hold only Treasury bills. Those who are willing to undertake greater risk can invest in mutual funds that hold privately issued CDs, bonds, or equities. Long-term, illiquid loans could be made by finance companies, which would raise funds by issuing equity and bonds. In the world I am describing, all household assets would be perfectly liquid. Preventing bank runs---he original motivation for deposit insurance--would be unnecessary, because changes in demand for various assets would be reflected in market prices. In essence, the system we have now is one in which finance companies are themselves financed with demand deposits. Yet these finance companies hold assets--long-term bank loans--that are risky and illiquid, much in the same way that fixed capital is risky and liquid. Imagine that the auto industry financed itself with demand deposits. Undoubtedly, self-fulfilling "runs" on GM and Ford would be common, and the auto industry would be highly unstable. Indeed, the auto industry would probably be a major source of macroeconomic instability. The best solution, of course, would not be deposit insurance and regulation of the auto industry, but a change in the way the industry financed itself.

We believe that the U.S. evidence on income and wealth shares for the top 1 percent is most consistent with a “superstar”-style explanation rooted in the importance of scale and skill-biased technological change. In particular, we interpret the fact that the top 1 percent is spread broadly across a variety of occupations as most consistent with an important role for skill-biased technological change and increased scale. These facts are less consistent with an argument that the gains to the top 1 percent are rooted in greater managerial power or changes in social norms about what managers should earn.

Will summer camp make my kids rich?

Paul Krugman, commenting on my recent article, thinks it is noteworthy that the rich have increased their spending on child enrichment programs. To me, that is not a surprise. The incomes of the rich have risen, and this category of spending, like many others, has a positive income elasticity.

I am a parent of three, and as far as I know, Paul does not have any children. So I have probably spent a lot more on this category than he has. And I can report that much of it is consumption, not investment.

A book I probably should have cited in my article is Judith Harris's The Nurture Assumption. The main thesis of this great book is that, beyond genes, parents matter far less than most people think. Raising three children has made me appreciate Harris's conclusion. It is frustrating how little influence we parents have.

I have a friend whose job it is to advise families of extreme wealth. She is often asked how to raise successful children who know they are going to inherit gobs of money. It is all too common to see kids raised in this environment becoming ne'er do wells. Her advice: Make sure they get a summer job. Rather than spending money on enrichment activities, have them learn what it is like to earn a living.

Friday, June 21, 2013

The Left on Just Deserts

I just got an email from the left-leaning Economic Policy Institute regarding their work on inequality. I was struck by this passage:

Since
the 1970s, the United States has become increasingly unequal in terms of
income, wages, wealth and opportunity. Today, 1 percent of Americans are taking
home nearly 20 percent of the country's total income and own nearly 35 percent
of the country's wealth. This means that you (yes, you!) are probably making
less money than you deserve to.*

Notice the emphasis on what "you deserve." They aren't following the logic of the conventional Mirrlees model: they aren't saying we should redistribute more because the marginal utility of the rich is so much less than the marginal utility of the poor and middle class. Rather, they are talking about what people deserve.If economists want their models to connect with the political debate, they have to spend less time emphasizing diminishing marginal utility and more time thinking about just deserts.That does not mean the EPI's conclusion is correct. But I think they are right about the framing of the issue._____*By the way, this was a mass email, not to me personally. I don't think EPI really thinks I am making less money than I deserve to.

Thursday, June 20, 2013

In Defense of Me

My new paper on the One Percent has generated a fair amount of Internet commentary. I won't respond to the critics. Time is scarce, and I am busy with other projects. For better or worse, I will leave the paper to speak for itself. (I should note that my paper is part of a forthcoming JEP symposium. I have not seen all the other papers, but from what I have seen, the symposium should offer a good, balanced group of perspectives.)

Regarding all that Internet commentary, I did enjoy this defense from Matt Nolan. Nolan was apparently a reader of my favorite textbook early in his life. His defense of me begins as follows:

When it comes to looking at policy, I started life fairly heavily left wing. When I started university at the age of 18, my first textbook was by Greg Mankiw. He was a Republican, while most of my economics reading at the time had been Marxist or a frustrated attempt at reading the General Theory by Keynes. I was immediately certain that I would hate the textbook, and that it had no value – at that point I was even more immature than I am now

I was utterly and totally wrong – a situation I have become accustomed to. Mankiw’s first year textbook is clear, to the point, and is honest about what the economic method is and what it achieves. He “wears his assumptions on his sleeve” which I have learnt is the distinction of the best type of economist. His textbook, and his papers on macroeconomics and tax, have been insightful for me as a way of not just understanding economic ideas, but of understanding the economic method.

Saturday, June 15, 2013

Defending the One Percent

Thursday, June 13, 2013

An All-Harvard CEA

With the news that Betsey Stevenson is joining the CEA, the three-member board will now have two Harvard PhDs and a Harvard professor. Just saying....

Update: A friend points out, "Actually, we have had an all-Harvard CEA for some time since Betsey is replacing Katharine Abraham (a Harvard Ph.D.) and Jason is replacing Alan Krueger (a Harvard Ph.D.)."

About Me

I am the Robert M. Beren Professor of Economics at Harvard University, where I teach introductory economics (ec 10). I use this blog to keep in touch with my current and former students. Teachers and students at other schools, as well as others interested in economic issues, are welcome to use this resource.